Leiden Law Blog - insolvencyhttps://leidenlawblog.nl
enk.i.m.van.leusden@law.leidenuniv.nlCopyright 20182018-08-07T08:00:00+00:00“Hacked” insolvencies of crypto exchangeshttps://leidenlawblog.nl/articles/hacked-insolvencies-of-crypto-exchanges
https://leidenlawblog.nl/articles/hacked-insolvencies-of-crypto-exchanges#When:July 5, 2018Have you ever invested on crypto exchanges? Whether the answer is yes or no, it is worth following their development and learning from the unfolding dramas of their failures. Faced with the unknown terrain of the crypto world, insolvency rules are tested.]]>

On 22 June 2018, the District Court of Tokyo issued an order commencing civil rehabilitation proceedings against MtGox Co. Ltd. (MTGOX). The previously ongoing insolvency liquidation proceedings were therefore stayed. This recent development signifies a crucial victory (although not final) for the creditors in the protracted and unusual insolvency proceedings of what was once the biggest crypto exchange.

MTGOX was the world’s largest Bitcoin trading exchange. Based in Japan, it handled around 70% of the world’s Bitcoin (BTC) trades in 2013. It allowed its users to buy, sell, convert and keep their Bitcoins and fiat currency in accounts deposited with the exchange. Following a massive hack, which led to the loss of around 850,000 Bitcoins worth USD 473 million at that time, MTGOX stopped all withdrawals and shut down its website early in February 2014. On 28 February 2014, it filed for insolvency protection in Tokyo under the procedure called civil rehabilitation (minji saisei), claiming that rebuilding MTGOX in a legally organised manner “will not be for the sole benefit of the company but for that of the whole bitcoin community.” The latter turned out to be problematic (as the crypto exchange users have not yet received anything) and the rehabilitation procedure soon grew into a full scale insolvency liquidation. Mr. Nobuaki Kobayashi, a Japanese attorney, was appointed as a bankruptcy trustee. As a defence from the multiple court proceedings launched against it, MTGOX filed petitions to have the Japanese insolvency proceedings recognised abroad. Such recognition was granted in the USA and Canada, giving the failed crypto giant the necessary breathing space and protection against asset seizure (e.g. computer servers and money in bank accounts).

Meanwhile the aggrieved crypto investors were left in a state of uncertainty, as the Japanese legal (and for that matter, insolvency) system was not geared towards resolving financial troubles involving hacked cryptocurrency exchanges. According to Japanese insolvency law and as confirmed by the trustee, in bankruptcy proceedings non-monetary claims, such as claims for the return of invested Bitcoins and other digital assets, are converted into monetary claims based on the valuation at the time of the commencement of insolvency proceedings. This means that MTGOX’s creditors could claim the value of the invested Bitcoins at the exchange rate as of April 24, 2014 (commencement of the insolvency proceedings), which was approx. USD 450 for 1 BTC. As is well known, the price of Bitcoins is extremely volatile and has dramatically risen since 2014, reaching record USD 19,000 in December 2017 (now trading at the level of ∼ USD 6,000). Please follow the link to see the graph accurately depicting the relations between the MTGOX’s creditor claims and the value of trustee holdings from 2015 till mid-2018.

It is clear that as a result of the insolvency proceedings, the creditors would lose out, should the surplus in the value of Bitcoins (∼ USD 5,500 per 1 BTC) bypass their pockets and end up in the hands of MTGOX’s shareholders, themselves accused of embezzling money from MTGOX and manipulating its data. This outcome not only lacks in fairness, but also contradicts one of the main principles of insolvency law – maximisation of the asset value for the benefit of creditors, whose interests override the interests of shareholders. However, in the case at hand, due to the increase in the price of BTC and the aforementioned specificity of Japanese insolvency law, the asset value has exceeded the amount of the claims, effectively pulling MTGOX out of insolvency. This situation is rather unprecedented and turns the insolvency process upside down. One can compare this rapid increase in the insolvency estate to the recent auction sale of the portfolio of technology patents owned by Nortel Networks, a Canadian telecommunications company. Originally estimated to be worth USD 900 million, its sale price went over USD 4.5 billion, primarily due to the fierce battle unfolding between Apple Inc., Google Inc. and Intel Corp. However, unlike with MTGOX, in the Nortel example the successful asset sale directly benefitted the creditors of the defunct telecom manufacturer.

In both scenarios, the asset price appreciation was determined by the growing demand. This is the law of supply and demand in action, demonstrating that low supply and high demand lead to price increase. As theoretical as it may sound, in practice it has turned into a real headache for Mr. Kobayashi as he was tasked to sell MTGOX’s Bitcoins. The amount managed by MTGOX surpassed 200,000 BTC or USD 1.2 billion (at today’s exchange rate). One of the major concerns was that a one-time or quick sale of BTC would cause a sharp decline in its price, ultimately hurting the creditors’ interests. In March 2018, the trustee confirmed selling Bitcoins worth approx. USD 400 million. Even though he argued that the sale was not through a BTC exchange but instead over the counter, a correlation between the sale and the BTC price drop was spotted. In my opinion, in the future, cryptocurrency price volatility and market sensitivity will be a recurring theme, requiring insolvency practitioners to cautiously approach its disposal and maybe even acquire the skills of a professional trader.

The unfairness of the ongoing “insolvency” proceedings in Japan has sparked anguish and discontent among MTGOX’s numerous creditors. “This mess is giving me anxiety”; “I wanna give up but I’m baked in so f**k it”; “There is no accountability there. You can “demand” all you want and they will just ignore you” – these are just a few recent comments left by the aggrieved investors in the special sub on Reddit. Some of them even started Mt.Gox Legal, a co-operative of over 900 creditors, “in order to share legal costs, advice and representation.” Apparently, the creditor’s activism has facilitated the replacement of the insolvency proceedings with the originally planned civil rehabilitation proceedings. This happened on 22 June 2018, when the Tokyo court made an order staying MTGOX’s insolvency proceedings. Most importantly, this meant that non-monetary claims no longer have to be converted into monetary claims, as would be the case if insolvency went on. Therefore, claims seeking a refund of Bitcoins will not be transformed into claims for the repayment of the monetary value of BTC calculated as per April 2014. When and how exactly the unfortunate crypto investors can receive their investments remains unclear, as Mr. Kobayashi now needs to prepare a rehabilitation plan, specifying the amount, timing and method of distribution. The problem is that such distribution lies relatively far in the future, i.e. not earlier than mid/end 2019. Nobody can predict what the BTC price will be next month, let alone next year.

While the failure of MTGOX is the most notable example of the insolvency of a crypto exchange, it is far from being the only one. In June 2018, a new chapter in the struggles around Italian crypto exchange BitGrail unfolded. Following the reported theft of approx. 17 million NANO (∼ USD 187 million), an altcoin almost solely traded on BitGrail, the court in Florence ordered seizure of its assets and appointment of a receiver to investigate its situation. Meanwhile, a group of crypto investors filed a class action suit in the United States District Court for the Eastern District of New York, alleging that they were misled into investing in BitGrail, advertised as a safe haven for crypto investors. Interestingly, the relief sought from the court includes an order requiring NANO to “rescue fork” the allegedly missing coins into a new cryptocurrency. Such forks are not new and have been used in the past to deal with the consequences of crypto collapses (e.g. the infamous debacle of The DAO, breaking Ethereum into two separate active blockchains, each with its own cryptocurrency). However, I am not aware of any cases in which hard forks have been a matter of a court order.

What can we learn from these examples of “hacked” insolvencies? First, they almost always involve a criminal element, i.e. a theft/embezzlement of crypto assets. Second, retrieval of such assets is oftentimes problematic and calls for close cooperation with (foreign) enforcement authorities. Third, the specificity of the crypto markets requires insolvency practitioners to have a special skill set, analogous to the one of a professional trader or a forensic investigator. And last, crypto exchanges are characterised by the dispersed creditor base leading to considerable collective action problems. However, technological progress has substantially mitigated such problems and made it easier for them to get together for the purposes of sharing information and costs, formulating legal strategies and exercising pressure on insolvency practitioners and courts. To a large extent, it is precisely this creditor activism that will define the fate of “crypto insolvencies”.

]]>Private Law,2018-08-07T08:00:00+00:00Ilya KokorinWhen bitcoin meets insolvencyhttps://leidenlawblog.nl/articles/when-bitcoin-meets-insolvency
https://leidenlawblog.nl/articles/when-bitcoin-meets-insolvency#When:March 22, 2018What is Bitcoin and how to find its owner? These questions were raised by the Russian court in March 2018 in the context of insolvency proceedings. In short, the court concluded that it had no idea what Bitcoin was and could not ascertain its ownership.]]>

The capital structures of companies in the 21st century will be starkly different from those of the last century. Once driven by hard assets, such as real estate, natural resources and machinery, modern businesses become highly dependent and valued on the basis of intangible assets – contracts, intellectual property and goodwill. Recent years have seen a rapid development of new technologies allowing for the creation of novel types of intangible assets with their own value and characteristics. There is hardly anyone these days who has not heard about Bitcoin or cryptocurrencies in general. Once thought to be a tool to avoid third party intermediaries (read banks) in financial transactions, crypto assets turned into an investment tool, characterised by price volatility, hyped private and public interest, as well as uncertainty regarding its legal status.

Bitcoin as the world’s first decentralised digital currency has become possible thanks to the blockchain technology – publicly distributed, shared and immutable digital ledger. Anonymity and irreversibility of transactions on blockchain have made it attractive for users. It is estimated that cryptocurrency market capitalization will hit USD 1 trillion in 2018. A lot will however depend on public perceptions (read trust) and government reaction. The latter so far has been rather mixed. Among rising fears of the technology being used in illicit activities (money laundering, extortion, financing of terrorism, etc.) and weak investor protection, state authorities struggle in finding a balanced solution. This becomes particularly difficult due to the lack of consensus on what cryptocurrencies actually are – securities, digital assets, currency, commodities or something else. But while regulatory and legislative bodies take their time to establish legal frameworks for the operation of the crypto market (tokens, coins, ICOs, crypto exchanges, etc.), courts have no such time and are faced with the need to resolve real disputes.

This is particularly so in the context of insolvency cases, in which several questions may arise. For instance, how to treat various types of digital assets belonging to the debtor, how to trace them in cases where the debtor refuses to disclose their existence, transfers them to third parties or simply refuses to provide access to the insolvency practitioner or court? And last, how to dispose of them and at what exchange rate, if any? Many of the indicated questions have been brought up in the recent bankruptcy case of Mr. Tsarkov, considered by the Commercial Court of Moscow (Russia) in March 2018, case No. A40-124668/17. In this case the insolvency practitioner (IP) filed a motion with the court asking to mandate the inclusion of the contents of the crypto wallet at www.blockchain.info (around 0,2 BTC amounting to approx. USD 2,300 as of the date of the judgment, 5 March 2018) allegedly owned by Mr. Tsarkov into the insolvency estate. In addition, the IP requested the key to the wallet to be handed over to him. The IP argued that Bitcoin was an asset, and since the primary purpose of the bankruptcy procedure was the sale of the debtors’ assets and value maximization to creditors, Bitcoin should fall under the insolvency estate. Mr. Tsarkov objected, claiming that current laws of Russia did not address relations involving cryptocurrency and that cryptocurrencies could not be an object of property (civil) rights.

Resolving the dispute and refusing to recognise Bitcoin as an asset for the purposes of insolvency law, the court essentially provided two arguments. Firstly, it noted that the legal nature of cryptocurrency is unclear and cannot by derived by analogy. Additionally (and for no particular reason), the court made references to various policy documents by the Central Bank of Russia, in which the latter stressed that digital coins are price volatile and can be used in high risk or shady transactions breaching anti-money laundering (AML) legislation. This argument seems rather unpersuasive to me. The court cannot simply walk away from adjudicating the issue because it finds it too difficult to understand. The fact that cryptocurrencies are not mentioned in law does not make them “outsiders” to the legal system – the objects of property rights are not exhaustively listed in Russian law and include “other assets” (Article 128 Russian Civil Code). Besides, in January 2018 the Russian Ministry of Finance proposed draft legislation defining ‘cryptocurrency’ as a digital financial asset existing in the distributed ledger of digital transactions. Exclusion of Bitcoins from the insolvency estate is detrimental to creditors’ rights as crypto assets have value and are relatively easy to dispose of, i.e. turn into liquid fiat currency.

Secondly, and more challenging for practical reasons, the court rightly pointed out that due to the anonymity inherent in the operation of (some) crypto wallets (e.g. registration at www.blockchain.info is free and only requires verification by email), the ownership over cryptocurrency in the wallet is hard to ascertain. Paradoxically, in the case at hand Mr. Tsarkov did not dispute the fact that the respective Bitcoins belonged to him – there was no disagreement about it. Nevertheless, the court was not persuaded. This of course was a strange decision. But let’s assume the debtor denied any connection to the said wallet or even its existence was hidden, for example its key ended up being in a decommissioned military bunker somewhere in Switzerland. In this scenario, it would be extremely difficult to link the debtor to a particular wallet. However, if there is sufficient evidence indicating that the wallet belongs to the debtor, he could be obliged to disclose its content (hand in the key) to the IP. Failure to do so may result in penalties (l'astreinte or another similar instrument) or denial of debt discharge upon closure of the bankruptcy proceedings. When dealing with the insolvency of a company refusing to cooperate with a court or IP, one can also consider resorting to the tool of director’s liability.

Whereas crypto wallets are hard nuts to crack, a different situation arises whenever cryptocurrency exchanges are involved. Unlike wallets storing data on Bitcoins or other cryptos, crypto exchanges allow customers to trade digital currencies for other assets, such as conventional fiat money, or different digital currencies. Therefore, most often such exchanges mandate more stringent customer identification, necessary to comply with the applicable KYC/AML standards. Under Japan’s so-called Virtual Currency Act, in force since 1 April 2017, crypto exchanges must comply with minimum capital requirements and implement advanced customer identification procedures. South Korea followed by banning anonymous cryptocurrency trading and obliging crypto investors to use real-name bank accounts. Even though European regulators are lagging behind, undoubtedly, they will soon follow their Eastern counterparts. The possibility to check the identity of traders on exchanges, whether at the request of a court or an IP, enhances transparency and simplifies digital asset tracking. However, the effectiveness of such measures may still be doubtful. First of all, by the time the court reacts, all coins owned by the debtor may be long siphoned from the exchange and become untraceable. And secondly, crypto exchanges may be located in jurisdictions which either do not cooperate with courts from other countries or do not prescribe full-fledged client identification measures.

While regulation of crypto assets is still in its embryonic stage, insolvency courts serve as a testing (‘battle’) ground, both in terms of defining cryptocurrencies’ legal status and finding practical ways of recovering and handling their value for the general benefit of creditors. In my previous blog I discussed the issue of decentralised autonomous organisations (DAOs) and jurisdictional challenges their failures lead to. Up next: Insolvency of crypto exchanges: international experience. Stay tuned.

]]>Private Law,2018-08-07T08:00:00+00:00Ilya KokorinProposal for a Restructuring Directivehttps://leidenlawblog.nl/articles/proposal-for-a-restructuring-directive
https://leidenlawblog.nl/articles/proposal-for-a-restructuring-directive#When:December 5, 2016A major harmonisation process on restructuring and insolvency law has been launched in the EU. What does it entail?]]>

On Thursday 22 November 2016 Vera Jourová, EU Commissioner for Justice, Consumers and Gender Equality, presented the long-awaited ‘Proposal for a Directive of the European Parliament and of the Council on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30/EU’ (‘Restructuring Directive’).

The proposal is the follow up to a non-binding recommendation to the Member States in March 2014 advising them to take steps towards the harmonisation of key topics in EU insolvency law aimed at a new approach to business failure and insolvency. Two goals were formulated: (i) to ensure that viable enterprises in financial difficulties, wherever they are located in the Union, have access to national insolvency frameworks which enable them to restructure at an early stage with a view to preventing their insolvency, and therefore maximise the total value to creditors, employees, owners and the economy as a whole, and (ii) to encourage greater coherence between the national insolvency frameworks in order to reduce divergences and inefficiencies which hamper the early restructuring of viable companies in financial difficulties and the possibility of a second chance for honest entrepreneurs, and thereby lower the cost of restructuring for both debtors and creditors. The European Commission is quite active in the field of insolvency. In the summer of 2015 it published its final recast of the European Insolvency Regulation (EIR 2015). In June 2017 it will replace the existing regulation (EIR 2000) which concerns private international law (conflict of law) issues, such as international jurisdiction, recognition and enforcement of insolvency judgements, applicable law, as well as communication and coordination of cross-border insolvency procedures by insolvency practitioners and court.

The proposal of 22 November 2016 obliges Member States to introduce sprecific types of procedures and set up measures to ensure that insolvency proceedings are effective with regard to promoting preventive restructurings and a second chance. Throughout the proposal’s development from March 2014 onwards, it has been set in the context of the Juncker Plan, the Action Plan on Building a Capital Markets Union and the Single Market Strategy, with the overall goal of strengthening Europe’s economy and the stimulation of investment in Europe. This initiative seeks to address the most important barriers to the free flow of capital, building on national regimes that work well, meaning that ‘(insolvency) laws’ should be drafted in such a way that it would be much easier for investors to assess credit risk, particularly in cross-border investments. Insolvency is put between brackets, as in certain Member States assessing credit risk relates to the creation and enforcement of security rights, including the transparency of systems of registration of assets.

The proposal, with 47 recitals and 36 Articles, introduces (i) common principles on the use of early restructuring frameworks, which will help companies continue their activity and preserve jobs, (ii) rules to allow entrepreneurs to benefit from a second chance, as they will be fully discharged of their debt after a maximum period of 3 years, and (iii) targeted measures for Member States to increase the efficiency of insolvency, restructuring and discharge procedures. These include reducing the excessive length and costs of procedures in many Member States, which result in legal uncertainty for creditors and investors and low recovery rates of unpaid debts, and ensuring proper training for courts and insolvency practitioners.

Restructuring evidently has ramifications in several other areas of law, e.g. financial law, labour law and company law. It is proposed that the Directive shall be without prejudice to (a) Directive 98/26/EC on settlement finality in payment and securities settlement systems, (b) Directive 2002/47/EC on financial collateral arrangements, and (c) Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories. Regarding labour law immunity is the leading principle. The Directive shall be without prejudice to workers’ rights guaranteed by Directives 98/59/EC, 2001/23/EC, 2002/14EC, 2008/94/EC and 2009/38/EC. A form of alignment is introduced to the area of company law. Articles 19(1), 29, 33, 34, 35, 40(1)(b), 41(1) and 42 of Directive 2012/30/EU45 provide for the necessity of convening a shareholders’ general meeting. If capital is increased by consideration in cash, Article 33 of the Directive establishes a pre-emptive right of shareholders to the new shares. Both the requirements for a shareholders’ general meeting and the pre-emption rights could jeopardise the effectiveness of the restructuring plan’s adoption and implementation. The proposal requires Member States to derogate from those company law provisions to the extent and for the period necessary to ensure that shareholders do not frustrate restructuring efforts by abusing their rights under Directive 2012/30/EU. In Article 32 it is proposed that in Article 45 of Directive 2012/30/EU, a paragraph 4 is added, with the text that Member States shall derogate from the Articles mentioned ‘… to the extent and for the period that such derogations are necessary for the establishment of the preventive restructuring framework provided for in’ the Restructuring Directive. The proposal has to be discussed and agreed upon by the European Parliament and the Council. After it has been finalised, an implementation period of two years is proposed. So in the period ahead there will be (and should be) discussion on the specific form of these preventive insolvency frameworks. On 27 January 2017 a group of international scholars, judges and practitioners will launch an exchange of ideas at the EYE building in Amsterdam. This will be the first contribution to collective thinking on the restructuring proceedings of the future.

The idea of China’s Inter-regional Cross-border Insolvency Arrangement (CICIA) reflects an ongoing trend concerning harmonization of cross-border insolvency law through internal legislation of regional institutions and also best practices set out in soft law, including guidelines and principles contributed by the international organization (UNCITRAL), non-governmental organizations (III, INSOL etc.) and even private parties active in the area of restructuring and insolvency law. That trend is a response to regional integration and globalization, which make inter-regional and international legal interaction intensify and the need for one jurisdiction to always apply its own law gradually reduced. Such harmonization is accompanied with challenges.

Sovereignty and Autonomy

Cross-border legal cooperation requires proper balance between “retention of forum-state regulatory authority and acknowledgment of the equal authority of other states within their own territory”. The classic perspective of cross-border insolvency went a bit further, which demands such cooperation abide by the principle of universality that attaches importance to concentration of insolvency proceedings within one forum. To follow the classic approach, it entailed that the states needed to compromise their sovereign authority for cooperation in cross-border insolvency. That approach has been only partly achieved in the EU, where, through its decade-long integration process, the Member States has delegated part of their “sovereign” function of law-making to the regional institutions on the basis of common values and legal principles. China’s reunification is based on the commitments that the Mainland would partly restrict its sovereign authority to guarantee the high degree of autonomy of the SARs. There is no sign of any further compromise in that regard so far.

Cooperation and Trust

In the more globalized societies of today, insolvency proceedings requires cooperation across more different jurisdictions around the world, which needs the balance on the varied level of trust among the jurisdictions. Without geographic advantages and shared culture, we no longer live enmeshed in such “thick trust relationships” as the EU legal system relies on. Against that background, the Model Law created an interconnected network structure via cooperation and communication between the judges and practitioners from various jurisdictions. That coordinated approach corresponds to the way the different jurisdictions interact with each other in a flattened globalized world and promote mutual understanding through directly exchange of information and opinions. Even though within a country, it is acknowledged that mutual trust is pretty much at the primary stage in China’s regional legal system. Therefore, CICIA chose to adopt the coordinated approach, which is not established on the basis of solid trust relationship but out of pragmatic necessity.

Integration and Conflicts

Integration is accompanied with uncertainty over the future. Whether or not the creditors can recover their claims in the event of trans-regional insolvency could be a conflict trigger. Given the fact that there is government interference, in particular local protectionism, on the insolvency proceedings in the Mainland, CICIA takes into account the balance between two equally important political considerations, i.e. the local prosperity and stability and the sound and sustainable development of regional integration. It thus recommends establishing a functional dispute settlement mechanism on the basis of inter-regional court-to-court cooperation and communication so as to keep the balance.

The Nordic-Baltic Insolvency Network was established in 2010. The network contains five EU Member States (Sweden, Finland, Estonia, Latvia and Lithuania) and two other countries: Norway and Denmark. The main reason for its establishment was the financial crisis that the Baltic States had endured. It revealed that there were considerable differences not only between these countries’ insolvency systems, but also between theirs and the Nordic region. This diversity was regarded as unjustifiable and not appropriate as it had a negative effect on willingness to invest in this part of Europe. The main purpose of the network therefore has been to encourage efforts towards the substantive harmonisation of insolvency law. The thought behind the network is to strengthen the Nordic and Baltic States’ participation and influence within such a process for the purpose of arriving at the first stage of developing common principles, which are suitable and much needed, in key areas where substantial legal differences can be found to exist. In autumn 2015 a final draft of the Nordic-Baltic Recommendations on Insolvency Law was presented. In this way the regional initiative to harmonise restructuring and insolvency laws is unique, be it that the alignment with the European Commission’s March 2014 Recommendation to the Member States to harmonise certain matters on insolvency law (see my blog: A new Approach to Business Failure and Insolvency) will be the object of further study. What the Nordic-Baltic Recommendations have in common with the EC’s initiative is that the emphasis lies on reorganisation law, as the legislation in the Nordic-Baltic region that has developed over the last 25 years has had hardly any consideration for the regulations of neighbouring countries. In light of the interaction between the regulations for liquidation and reorganisation, the Network (some 40 academics and practitioners from the seven countries, chaired by Erik Selander of DLA Piper Stockholm) also developed recommendations on important liquidation issues.

The result of the Network is certainly worth looking at. After listing eight overall objectives and features of an effective and efficient insolvency law, it formulates recommendations on a whole range of topics that – when comparing European countries – are different in nearly every respect: (1) application and commencement of insolvency proceedings, (2) representatives’ liability due to the continued operation of insolvent companies, (3) immediate legal effects of the commencement decision, (4) treatment of the debtor’s contracts, (5) treatment of pending lawsuits in liquidation proceedings, (6) recovery to the estate, (7) insolvency claims, (8) the order of priority regarding insolvency claims, (9) proof of debt procedure, (10) treatment of post-commencement claims, (11) administration of insolvency proceedings, (12) the reorganisation plan, (13) treatment of environmental claims in insolvency proceedings, (14) treatment of groups of companies in insolvency proceedings, and (15) short-term protection of voluntary restructuring negotiations.

The Nordic-Baltic Network is not unambitious. The whole amalgam of seven national countries’ characteristics of insolvency law have been couched in one set of non-binding recommendations and it will be difficult to find one missing. The first objective of effective and efficient insolvency law, as envisaged by the network, is: ‘The general objective of insolvency law is to maximize efficiency of the economy by facilitating trade and supporting an effective credit system and a favourable investment climate.’ What is so typical in insolvency law (its function to protect a creditor’s interest) is missing. Insolvency law is presented as a building block in the economy, to support the general welfare, an inherent element of the (European and national) market. Also the second objective is not creditor focused, but instead places the debtor company at the centre of attention (‘Insolvency law shall provide a transparent, predictable and cost-effective set of rules that allows, based on the circumstances of the individual case, the preservation and maximising of the value of the debtor’s assets by enabling, on the one hand, reorganisation of viable businesses and, on the other hand, rapid liquidation of businesses that have no prospect of survival). Suffice to say, we can expect vivid discussions, not only between insolvency scholars and practitioners, but also when national legislatures are confronted with these rules, in their effort to amend laws based on the European Commission’s and the Nordic-Baltic Recommendations.

]]>Private Law,2018-08-07T08:00:00+00:00Bob WesselsV&D and the arbitrariness of rescuing businesseshttps://leidenlawblog.nl/articles/vd-and-the-arbitrariness-of-rescuing-businesses
https://leidenlawblog.nl/articles/vd-and-the-arbitrariness-of-rescuing-businesses#When:January 26, 2016Why do communities/governments support banks and football clubs but not V&D? Similarities exist between these cases. Comparison shows the arbitrariness of supporting (insolvent) businesses directly or indirectly.]]>

The essence of business life is the quest for value. A business can only survive if it creates, delivers and captures value. Generating value is the outcome of an uncertain process. Businesses that do not create value ultimately fail and are liquidated or sold. In principle the market selects value-creating firms to continue their business, but sometimes authorities facilitate failed businesses to recover. This is done directly – support by way of injecting cash – or indirectly - via business rescue supportive insolvency regulations. This policy increases the subjectivity and arbitrariness of facilitating insolvent businesses to recover. The question runs deeper and is more fundamental: what is the purpose of aiding insolvent businesses? Comparing department store group V&D with the ABNAMRO bank and football clubs turns up remarkable correspondence indicating various reactions to insolvent businesses.

Peter De Waard (column in De Volkskrant 29 December) compares the V&D insolvency with the ABNAMRO case. The Dutch government nationalised ABNAMRO (but not DSB) because of the dangers of the financial sector becoming contaminated. Considering the complex connections between financial institutions, a chain reaction – a financial meltdown – was possible. This could have paralysed the real economy with severe effects for growth and employment.

How harmful is the collapse of V&D for our society and cities? It could be disruptive for city centres and affect the attractiveness of other retail stores – a city centre melt down? Many high streets will empty and pauperise, ripping out the heart of these cities. They will become less attractive for other shops and visitors; a downward spiral which cannot be stopped easily. This will have consequences for the 10,000 employees and 1,800 suppliers of V&D – another chain reaction? According to De Waard V&D could be labelled a “system warehouse” because of economic, infrastructural, social and security reasons. Isn’t V&D too big to fail? Minister Kamp of Social Affairs proclaimed to do everything to keep V&D alive, but of course he cannot take action because of state aid problems.

Another comparison can be made between V&D and football clubs. The ultimate goal of a football club is the number one positon in the premier league or, even better, to win the Champions trophy. Football clubs cannot score by making a profit; they can only “score with goals” and their rank in the competition. In most cases communities have a stake in their football club’s stadium. A report by KPMG in 2003 concludes that communities are the “twelfth player”. If a football club goes bankrupt, its stadium becomes somewhat useless (see for other problems with football clubs my 2010 article in Economisch Statistische Berichten, in Dutch). A lot of football clubs have ‘sugar daddies’ – like the Chinese Hui Wang at FC Den Haag. They incidentally invest a lot of money, but influence the policy of football clubs and demand sportive success. Usually expenses increase structurally. So football clubs run into financial troubles again and again, “L'histoire se répète”. Financial support of a football club is justified on the grounds that a city “needs” the football club; it influences the “wellbeing” of the city – the football club promotes the city. Because of problems with state aid, a lot of constructions emerge that emphasise the infrastructural character of the football club. But as with ABNAMRO the origin is the same: Football clubs do not create (enough) value.

Because of the local city-bound character of football clubs this also corresponds to V&D which has 62 branches dispersed throughout cities and towns in the Netherlands. It attracts 100 million visitors a year! – a kind of forum or platform that draws people in. (The Dutch premier league attracted 5.7 million visitors during the 2014/2015 competition). Like FC Den Haag, V&D has had a capital investor and owner since 2010: Sun Capital Partners. Sun Capital invested 170 million euro in V&D but in December 2015 withdraw their support because of poor performance ascribed to warm weather conditions.

V&D was founded by Willem Vroom and Anton Dreesman in 1887. Their strategy was revolutionary at the time: to sell for low but fixed prices. During its lifetime V&D has belonged to different groups (e.g. Vendex and KBB). Its business history reveals a fascinating perspective of the complexity of doing business. Although they did not change their formula, V&D managed to survive – under different umbrellas. In the last twenty years (!) V&D has never realized a profit. They could compensate the losses with the profits from La Place, its successful restaurant chain. This was detrimental for the development of La Place. Immediate emotional reactions followed after the demise of V&D. The major of Haarlem stated that “he cannot imagine a city without V&D; it would be a severe loss to the city. Other economic activities would be severely hampered. V&D Haarlem attracts 1.7 million visitors who also promote other economic city-bound activities. The city ‘needs’ V&D. If we can contribute to keeping V&D alive, we will not hesitate to do so. However it is not for us to decide”. This harps back to ancient times when cities were highly specialised in goods such as beer, herring, or drapery and were usually subsidised by local authorities, or the VOC which was monopolised by the Dutch State.

Of course the cases do not match 100%, but there are similarities in the origin and the consequences of failure and the way authorities are involved or have responded. This raises the fundamental question: what is (or should be) the purpose of insolvency proceedings? Usually support is based on emotions and fears. We are inclined to believe that businesses are or should be successful, prosper, grow and survive. However businesses have a limited lifetime. In principle authorities can save every firm, directly or indirectly. It can always be asserted/justified that a business is viable, valuable, needed or necessary. However the government should not select viable firms; the market can do that. Many connections exist in the economy - it can be considered a complex business ecology. Governments should not add complexity, but should try to reduce complexity with simple rules. Arbitrary state aid (directly through financing and indirectly through new business rescue regulations) to insolvent businesses adds complexity.

These comparisons show that state support is arbitrary. Aiding insolvent businesses is subjective, arbitrary, complex, distorts competition and can be detrimental to healthy firms.

I used a range of press sources from various newspapers and, shame on me, Wikipedia for the historical overview of V&D.

]]>Tax Law and Economics,2018-08-07T08:00:00+00:00Tim VerdoesDie Fraudi und das Autohttps://leidenlawblog.nl/articles/die-fraudi-und-das-auto
https://leidenlawblog.nl/articles/die-fraudi-und-das-auto#When:October 27, 2015Was it merely the use of a small piece of fraudulent software or the undisciplined pursuit to become the biggest and most successful car manufacturer that threw Volkswagen into disarray? The public apology by Volkswagen from a different perspective.]]>

On my way back from the INSOL Europe Conference in Berlin I read a copy of Bild Zeitung where a full-page advertisement by Volkswagen caught my eye. In this advertisement the Board of Volkswagen sincerely apologised for the recent diesel scandal and stated that the company will do everything in its power to win back the trust of its customers, employees and rescue its business relationships. Naturally, the scandal at Volkswagen was a topic of discussion during the conference. Speculations of who will represent Volkswagen in the United States and whether Volkswagen might even file for bankruptcy were easy conversation points during coffee breaks at the conference.

Yet, during all these conversations and while reading the advertisement in Bild Zeitung a well-known saying crept to mind: “trust is hard to gain, but easy to lose”. For companies in trouble, trust among its creditors, customers, employees and business contacts is essential to survive. However, regaining trust is perhaps one of the hardest tasks a company can face. Will customers for example still be interested in buying a car which does not perform as had been claimed in the past? The image of Volkswagen has suffered a considerable blow. Although restoring trust is most likely one of the aspects Volkswagen will have to address, a more fundamental problem must be taken into account by Volkswagen as well.

Becoming number 1

One can wonder if the problems Volkswagen is facing were merely caused by a small piece of emissions software and the subsequent PR debacle, or if the naked ambition of Volkswagen to become the most successful, fascinating and sustainable automobile manufacturer in the world could be the underlying problem. This desire by the Board of Volkswagen to expand in order to become the biggest car manufacturer in the world and overtake Toyota, might have led to the undisciplined pursuit of more. By climbing up the food-chain in order to be the number 1 car manufacturer around the globe, Volkswagen set out on a steep climb where the path gets narrower and the abyss deeper. A minor slip up can then have substantial consequences.

Perhaps to the untrained eye this may seem like a ‘chicken and egg’ situation all over again, as one can wonder what is the true cause of the problems Volkswagen is facing. The use of the fraudulent emissions software or the mere desire to grow and sell the most cars in the world? Yet fraud or fraudulent behaviour is not considered one of the more common causes of financial distress. Argenti (1976) ascertained many years ago that fraud is rarely associated with failure unless the (financial) distress is part of a fraudulent plan. This seems to apply to Volkswagen as the use of fraudulent emissions software was most likely based upon the desire to sell more cars and was not part of a covert fraudulent plan.

The pursuit of unrestrained success

This pursuit of more scale, growth or more of whatever one defines as ‘success’ can be explained by the “curse of success theory” propagated by both Miller (1990) and Ranft and O’Neill (2001). They state that success breeds failure in the sense that it creates overconfidence, hubris and arrogance which can spiral a company into decline. Due to past success, the Board of Volkswagen may have become insulated and viewed this success as a form of entitlement. Once success has been tasted, company directors simply want more. The most successful companies in the past can become the most vulnerable to failure in the future, according to Whetten (1988).

In any case, bankruptcy practitioners and academics shall have to wait to see how events unfold at Volkswagen with the added benefit of hindsight of course. For now, I myself should perhaps settle for reading “The Very Hungry Caterpillar” by Eric Carle to my young nephew Noah. In order to practice modesty or restraint instead of pursuing the impossible.

]]>2018-08-07T08:00:00+00:00Anthon VerweijNortel Networks Judgment a milestone in development of European insolvency lawhttps://leidenlawblog.nl/articles/nortel-networks-judgment-a-milestone-in-development-of-european-insolvency
https://leidenlawblog.nl/articles/nortel-networks-judgment-a-milestone-in-development-of-european-insolvency#When:August 31, 2015Nortel Network case, decided by the Court of Justice of the EU in June 2015, is a cradle for new rules in applying the EU Insolvency Regulation.]]>

The Court of Justice of the EU on 11 June 2015, Case C-649/13 (Comité d'entreprise de Nortel Networks SA and Others v Cosme Rogeau and Cosme Rogeau v Alan Robert Bloom and Others) delivered a significant judgment, both for the EU Insolvency Regulation’s rules on international jurisdiction as well as those on the law applicable and the way courts in cross-border insolvency cases jointly have to come to decisions. Although this Nortel case (with main proceedings in England and a secondary proceeding in France) deserves much more study, I take five conclusions from the CJEU’s judgment:

(1) It confirms the determination of the matter of international jurisdiction, more specifically the relationship between the EU Insolvency Regulation and Brussels I (specifically referring to Nickel & Goeldner Spedition, C 157/13);

(2) The disputes before the referring French ‘secondary’ court fall within the context of the application of a large number of agreements concluded by or between the parties before it, including, in particular an Interim Funding and Settlement Agreement (between the Canadian Nortel Networks Limited and a number of subsidiaries in the Nortel group), an intra-group Master R&D Agreement’, a ‘coordinating protocol’ and a ‘memorandum settling the action’ between the insolvency practitioners involved. The CJEU concludes that it is apparent that the rights or obligations on which the actions before the referring French secondary court are founded derive directly from insolvency proceedings, are closely connected with them and have their source in rules specific to insolvency proceedings, and therefore it concludes that the EIR is applicable;

(3) Where for main insolvency proceedings Article 3(1) EIR also confers international jurisdiction to hear and determine related actions on the Member State within the territory of which the insolvency proceedings have been opened (the CJEU refers in particular to the judgment in F-Tex, C 213/10), it now decides that for secondary proceedings Article 3(2) EIR must be regarded (also) as conferring international jurisdiction to hear and determine related actions on the courts of the Member State within the territory of which secondary insolvency proceedings have been opened, in so far as those actions relate to the debtor’s assets that are situated within the territory of that State;

(4) Both the main as well as the secondary courts have jurisdiction, concurrently or ‘jointly’ to rule on the determination of the debtor’s assets falling within the scope of the effects of the secondary proceedings;

(5) Finally, the CJEU sets out a marching order for the French court to decide on the location of the assets. This court has the task of establishing (i) whether the assets at issue are property or rights ownership of or entitlement to which must be entered in a public register, or (ii) whether they must be regarded as being claims. Next (iii), that court will have the task of determining, respectively, whether the Member State under the authority of which the register is kept is the Member State in which the secondary insolvency proceedings have been opened, namely the French Republic, or (iv) whether, as the case may be, the Member State within the territory of which the third party required to meet the claims has the centre of his main interests is the French Republic. It is only if one of those checks has a positive outcome that the assets at issue will fall within the secondary insolvency proceedings opened in France.

A remark accompanying my fourth conclusion.

Where the courts of the Member State in which the main proceedings have been opened also have jurisdiction to rule on related actions and therefore to determine the scope of the effects of the latter proceedings, the CJEU holds (paragraph 42), that: ‘Accordingly, exclusive jurisdiction of the courts of the Member State in which secondary insolvency proceedings have been opened to rule on the determination of the debtor’s assets falling within the scope of the effects of those proceedings would deprive Article 3(1) of Regulation No 1346/2000 of its practical effect in so far as that provision confers international jurisdiction to rule on related actions and, therefore, cannot be upheld’. If I read this correctly, the CJEU has created a ‘broad’ jurisdiction for the secondary court, but that cannot be upheld, because of the strong jurisdiction of the main proceeding. Or does it say that by its new ‘broad’ jurisdiction decision, the result is that the jurisdiction of the main proceedings will be eroded? It should be noticed that several parties have submitted that the recognition, in this context, of concurrent jurisdiction entails the risk of concurrent and, potentially, irreconcilable judgments. On the other hand the Advocate General has observed (point 60 of his Opinion, to which the CJEU refers), that Article 25(1) EIR will enable the risk of concurrent judgments to be avoided by requiring any court before which a related action, such as those before the referring French court, has been brought to recognise an earlier judgment delivered by another court with jurisdiction under Article 3(1) EIR or, as the case may be, Article 3(2) EIR. The CJEU decides (paragraph 46): ‘In the light of all the foregoing considerations, … Articles 3(2) and 27 of Regulation No 1346/2000 must be interpreted as meaning that the courts of the Member State in which secondary insolvency proceedings have been opened have jurisdiction, concurrently with the courts of the Member State in which the main proceedings have been opened, to rule on the determination of the debtor’s assets falling within the scope of the effects of those secondary proceedings.’ Evidently this will create huge challenges for judges, acquainted as they are to independency. On how to act and how to set up such a cross-border decision framework, assistance can be found in recent Leiden research, the results of which were published last month.

]]>Private Law,2018-08-07T08:00:00+00:00Bob WesselsWhat if… your bank fails? Recent European developments in the field of bank insolvency lawhttps://leidenlawblog.nl/articles/what-if...-your-bank-fails-recent-european-developments-in-the-field-of-ban
https://leidenlawblog.nl/articles/what-if...-your-bank-fails-recent-european-developments-in-the-field-of-ban#When:November 17, 2014Do you have a bank account? If so your position can suddenly change significantly as from next year. By the end of 2014, a large part of the rules of the Bank Recovery and Resolution Directive have to be implemented by the European Member States.]]>

Do you have a bank account? If so your position can suddenly change significantly as from next year. By the end of 2014, a large part of the rules of the Bank Recovery and Resolution Directive ('BRRD') have to be implemented by the European Member States.

The BRRD aims to establish a more harmonized European bank insolvency framework and equips national authorities with an expanded set of powers and tools to plan and manage the failure of a bank. When a bank is failing or is likely to fail, (some parts of) its business can be sold to another bank or can be transferred to a temporary institution controlled by the government. Moreover, to avoid resorting to public funds as much as possible, the costs of a recapitalization of the bank have to be borne by the creditors and the shareholders to a large extent. Authorities can reduce (even to zero), cancel and convert your claim on or share in a failing bank. Deposits at the bank up to €100,000 are in principle excluded from the scope of this so-called bail-in tool, though.

The developments continue. From January 2016 onwards, decisions about the restructuring of significant banks in the Euro Area and in other participating Member States, will not be taken on a national level anymore, but by one agency on a European level. In the Netherlands, inter alia, ABN AMRO Bank, ING Bank, Rabobank and SNS Bank are among these banks which are considered to be significant. The agency, i.e. the Single Resolution Board, has to ensure the unified application of the BRRD tools and powers just referred to. The measures will finally be implemented by the national authorities. Moreover, in its decisions the Board can require contributions from a common fund, which contains ex-ante contributions of all banks in the participating Member States. Yet before this can be considered a large part of the losses of the failing bank have to be borne by the creditors and shareholders first.

At the moment of writing, all Member States in the European Union are developing legislation to implement the BRRD. Yet there will be even more future developments in the field of European bank insolvency law. Since 1994 European Member States are required to provide for a national scheme that guarantees money deposited in a bank account up to a certain amount in case the bank fails. Although these so-called deposit guarantee schemes have been further harmonized in the European Union throughout the last two decades, according to many studies and reports a single pan-European deposit guarantee scheme should be the next step in the field of depositor protection and should complement the current European bank insolvency framework. Will your deposit in the future be guaranteed by the same deposit insurance fund as the deposits of our German neighbours?

The question ‘What is the effect of the strengthened and expanded European bank insolvency regime on the interests of, inter alia, creditors and shareholders of banks on a national level?’ is one of the questions that will be addressed in the workshop ‘The financial crisis and the impact of Europe on national parliamentary and stakeholder interests’ at Leiden Law School’s ILS Conference ‘Room for reflection’ in January 2015.

In a 2012 study, University of Heidelberg professor Andreas Pieckenbrock compared insolvency laws of England, Italy, France, Belgium, Germany and Austria. He concluded that there are five common tendencies in these rescue proceedings:

Early recourse – Sometimes there is an earlier moment at which the rescue process is started, for instance in the French Sauvegarde: when a debtor has encountered problems that he cannot solve, which is earlier than the traditional moment when the debtor cannot pay his financial obligations when they are due;

Debtor in possession – The board is not fully replaced by the insolvency administrator; in certain proceedings the board stays in control of the business, what we call ‘debtor-in-possession’;

Stay – In these countries one finds a moratorium or a stay which is either automatic like in the Sauvegarde, or upon request (for instance the concordato preventivo or réorganisation judiciare);

Protecting fresh money – There are special provisions to protect fresh money made available to the company whilst it is trying to work itself out of its misery;

Debt for equity swap – The possibility of a debt for equity swap, i.e. the conversion of a creditor’s claim into shares in the capital of the company.

Binding disapproving creditors – Generally, as Pieckenbrock explains, such a rescue is based on the principle of a composition or an arrangement concluded between the insolvent debtor and his creditors. Such a rescue plan is binding for those creditors who voted in favour of the plan, but is also binding upon a (given percentage) of a dissenting minority of creditors (sometimes referred to as ‘cram-down’) or a watering down (‘bail-in’) for altgesellschafter (ie. existing shareholders).

In a study by INSOL Europe on a new approach to business failure and insolvency, published in April 2014, the report authors (University of Milan professor Stefania Bariatti and Robert van Galen) studied 28 EU Member States. It is interesting to note that generally professor Piekenbrock’s characteristics are available in new or renewed recovery proceedings in nearly all member states.
On 12 March 2014 it issued a Recommendation on a new approach to business failure and insolvency. The Recommendation has 20 recitals and 36 recommendations. It seeks to reach these goals by encouraging Member States to put in place ‘… a framework that enables the efficient restructuring of viable enterprises in financial difficulty and give honest entrepreneurs a second chance’. The Recommendation provides for ‘minimum standards’ on ‘preventative restructuring frameworks’ to be implemented in all Member States. Through promoting adherence to these standards throughout the Union, the Commission’s hopes are threefold:
- for national insolvency systems - to improve the existing means for resolving distress in viable enterprises and encourage coherence in initiatives or reviews of ‘corporate rescue framework’ in all Member States,
- for businesses - to improve access to credit, encourage investment and to smoothen ‘… the adjustment for over-indebted firms, minimising the economic and social costs involved in their deleveraging process’, and
- for creditors - to improve mechanisms for resolving financial distress efficiently, with reduced delays and costs and limited court formalities (‘… to where they are necessary and proportionate in order to safeguard the interests of creditors and other interested parties likely to be affected’).
The Recommendation’s proposals are generally focused on those themes prof. Pieckenbrock has addressed.
Within twelve months (i.e. before April 2015), EU Member States are invited to implement the Recommendation’s ‘principles’. The expected endgame is that eighteen months after adoption of the Recommendation (so in October 2015) the Commission will assess the state of play, based on the yearly reports of the Member States, to evaluate whether further measures are necessary to strengthen the European approach. The Recommendation, formally, reflects a soft approach. It invites Member States to take or continue action. Substantially it only presents a ‘minimum standard’, allowing Member States to add specific conditions and components in order to allow the preventive restructuring framework to operate within the legal context and economic environment of its national market. It is the bare minimum, as there is no clear principle stating that the debtor should not take any action which might adversely affect the prospective return to relevant creditors (either collectively or individually) by a certain reference date. Nor is there a principle stating that the debtor should provide and allow relevant creditors and/or their professional advisers reasonable and timely access to all relevant information relating to its assets, liabilities, business and prospects, in order to enable proper evaluation to be made of its financial position and any proposals to be made to relevant creditors. A solid, comparative analysis during 2015 will be necessary to assess whether other binding measures are appropriate to reach the Commission’s policy goals. If the new Commission, under the leadership of Mr. Juncker, maintains this policy (which I would endorse), we will hear from the Commission, as in many states the process of legislating will most likely take many years. However legislation in Germany, Spain and France, and proposals being made in the Netherlands, are of a similar nature to the content of the Recommendation (an extended version of this blog, including footnotes, will appear on my blog, see www.bobwessels.nl.)